Simple (But Effective) Safe Haven ETFdb Portfolio

Published on August 22, 2011 | Updated February 11, 2014

Portfolio Strategy

The Simple (But Effective) Safe Haven ETFdb Portfolio is designed as a tactical position for investors looking to shift positions into asset classes that generally perform well during times of economic uncertainty and maintain relatively low volatility during times of chaos and panic on Wall Street. At the same time, this ETFdb Portfolio strives to maintain some of the upside potential that exists from holding equity positions; this portfolio is a strategy for investors who are looking to temporarily scale back risk instead of fleeing from risky assets altogether. The investment thesis behind this portfolio is quite simple; its core holdings are asset classes which are generally considered to be various degrees of “safe havens,” appealing to investors during times of panic-selling and attracting capital inflows when investor sentiment is generally pessimistic across other corners of the market. It should be noted that the not all components of this ETFdb Portfolio will necessarily gain value when broader equity markets slump; rather, as a group this ETFdb Portfolio should perform relatively well when volatility spikes. Investors looking to eliminate risk entirely would be better off considering significant position in the ETFs grouped in the Money Market ETFdb Category.

The Simple (But Effective) Safe Haven ETFdb Portfolio is a blend of equity, commodity, and fixed income holdings, all of which have the potential to take on safe haven appeal during periods of high market volatility. From a historical perspective, this portfolio has a tendency to either surpass or match the performance of the S&P 500; however, its volatility is considerably lower, making for a very appealing risk/return profile [see Historical Return Analysis below].

Investors should consider using this portfolio, or certain parts of it, as a tactical allocation to complement their existing holdings during times of uncertainty when markets seem directionless or when they need to scale back their risk appetite. This portfolio should not be considered as a viable long-term investment strategy since it lacks proper diversification across market cap levels and geographic regions, excluding small cap equities and emerging markets entirely.

  • Risk Tolerance: Low to Moderate. Equities receive the heaviest weighting, making this portfolio moderately risky, although the equity exposure in concentrated in safer corners of the market and complemented nicely with a broad fixed-income fund.
  • Time Horizon: Intermediate. This portfolio is by no means ideal over the long-run since it lacks proper diversification, although it may be appealing as a buy-and-hold in some instances when economic hardships are expected to continue for some time.
  • Current Income Needs: High. The current income portfolio of this portfolio is fairly high since all equity holdings generate relatively stable and meaningful dividend payouts, and the fixed income component is a solid source of yield as well.

Portfolio Snapshot

The following table presents the base weightings for each component of the Equal Weight ETFdb Portfolio. In addition, we have included alternative ETFs corresponding to each portfolio component:

Ticker ETF Asset Type Allocation Expense Ratio Alternative ETFs
XLU Utilities Select Sector SPDR U.S. Equities 20% 0.18% VPU, JXI
KXI iShares S&P Global Consumer Staples Sector Index Fund International Equities 20% 0.48% IPS, RHS

IDV

iShares Dow Jones EPAC Select Dividend International Equities 20% 0.50% VIG, DVY
DBP PowerShares DB Precious Metals Fund Commodities 20% 0.79% GLTR, JJP
AGG iShares Barclays Aggregate Bond Fund Fixed Income 20% 0.08% BND
Weighted Average Expense Ratio     0.41%

Historical Return Analysis

Ticker 2009 2010 2011 2012 2013
XLU 11.7% 5.4% 19.5% 1.0% 13.1%
KXI 21.8% 13.2% 9.1% 13.8% 19.6%
IDV 60.6% 11.9% -7.2% 19.4% 18.5%
DBP 26.6% 37.6% 4.0% 5.9% -31.4%
AGG 3.3% 6.4% 7.7% 3.8% -2.0%
Portfolio 24.8% 14.9% 6.6% 8.8% 3.5%
Compare to SPY 26.3% 15.0% 1.2% 16.0% 32.3%
Compare to AGG 3.3% 6.4% 7.7% 3.8% -2.0%

The adjacent table provides historical results for each component of this ETFdb Portfolio, as well as backtested results (as available) for the entire portfolio from 2008 to 2012. The table also shows how this ETFdb Portfolio performed relative to a popular stock market benchmark (SPY) and bond benchmark (AGG).

Not surprisingly, this ETFdb Portfolio struggled in 2008 and again in 2011 amidst a broad market recession. In 2009, 2010, and 2012 this ETFdb Portfolio reclaimed much of the ground lost during 2008 and 2011. When comparing the difference in performance and volatility over the past three years, it’s fair to say that this Simple (But Effective) Safe Haven ETFdb Portfolio does a fine job of serving as low-volatility alternative to broad-based equity funds, still capable of capturing tremendous gains during times of prosperity. During the market slump in 2008, this portfolio took a hard hit, although it still managed to outperform SPY by nearly double in terms of both performance and volatility. What’s even more appealing is that during the recovery in 2009, 2010, and again in 2012, this portfolio was able to match the returns of SPY, while doing so with roughly half the volatility.

Portfolio Expenses

Though this ETFdb Portfolio is not specifically designed for long-term use consistent with a “buy, hold, and rebalance” strategy, we still strive to minimize expenses incurred. To this end, we constructed a portfolio with a weighted-average expense ratio of just 41 basis points, which is significantly lower than fees charged by actively-managed mutual funds (we’ve assumed an expense ratio of 1.0%, which is probably a conservative estimate of the effective fees charged by an all-mutual fund portfolio). The impact of this reduced costs structure over the horizon of this portfolio is significant:

    Growth of $1 Million Over 30 Years @ Annual Return Of:
Portfolio Expense Ratio 5% 10% 15%
Simple (But Effective) Safe Haven ETFdb Portfolio 0.41% $3,847,717 $15,617,206 $59,546,518
Actively-Managed Mutual Fund Portfolio 1.00% $3,243,398 $13,267,678 $50,950,159

Holdings Overview

Below is a brief overview of each component of this ETFdb Portfolio.

  • XLU: This ETF tracks the Utilities Select Sector Index, providing exposure to domestic utilities companies.
  • KXI: This fund gives investors broad-based exposure to the performance of the consumer staples sector of global equity markets.
  • IDV: This ETF tracks the Dow Jones EPAC Select Dividend Index, which measure the performance of companies that have provided relatively high dividend yields on a consistent basis over time.
  • DBP: This ETF provides investors with futures-based exposure to gold and silver prices.
  • AGG: This fund tracks the Barclays Capital U.S. Aggregate Bond Index, which measures the performance of the U.S. investment grade bond market.

Portfolio Risk Analysis

Since this portfolio is designed to have appeal to investors seeking safe haven, it should be no surprise that many of the holdings maintain relatively moderate risk profiles. Though equities account for a significant portion of the portfolio, these positions are focused on stable asset classes that generally exhibit low volatility and high dividend payments. The international equity allocation focuses on companies that should also exhibit low volatility thanks to relatively attractive dividend yields.

It should be noted that DBP, which offers exposure to gold and silver, futures contracts, is capable of big swings in either direction over relatively short periods of time. However, this fund generally performs well in uncertain economic environments, since precious metals usually appreciate when equity markets encounter turbulence.

Equity holdings usually exhibit a strong correlation with one another; however, the particular combination of asset classes as a whole does a good job of offering a source of uncorrelated returns when markets are moving in tandem and when they appear to be directionless. This portfolio offers a risk/return profile very different that most traditional portfolios given that it lacks proper diversification across equity market sectors and regions, and rather focuses on delivering exposure to corners of the market that are likely to benefit from capital inflows during times of panic on Wall Street.

Equity Overview

This ETFdb Portfolio contains an allocation of two-thirds of its holding to equities, spread out across defensive corners of the stock market and allocating assets to both domestic and foreign companies. Given the safe haven theme of this portfolio, we have entirely excluded exposure to emerging market equities, although many of the multi-national companies in IDV and KXI are still positioned to profit from operations in developing regions.

As shown in the adjacent chart, the equity component of this ETFdb Portfolio consists primarily of large cap stocks. Large cap equities have historically held up much better in times of economic downturns than their smaller and mid-cap size counterparts, in addition to offering less volatility in prosperous times as well. For that reason we have included equity ETFs with primarily giant and large-cap size holdings in an effort to stay true to this portfolios  safe haven investment strategy.

Investors looking to add emerging market exposure while still remaining consistent with a defensive approach should consider PXR, which offers broad-based exposure to companies involved in infrastructure construction and development in emerging market countries.

XLU [Fact Sheet]

One particular asset class which we believe to be a true safe haven within the equity space is the utilities sector. The demand for the products and services provided by this corner of the market is relatively stable, and utilities generally have a consistent record of distributions. This sector of the market is known for relatively low volatility in both directions; the upside potential during bull markets may be limited, but this asset sub-class also tends to hold its value better when markets decline.

As such, we view XLU as a way to scale back risk exposure while still maintaining an equity position. Because this sector exhibits a relatively low correlation with broader markets, a hefty allocation to utilities can dampen any losses experienced amidst broad stock sell-offs.

XLU is the biggest fund offering exposure to the domestic utilities sector and it holds a portfolio of the largest companies from the following industries: electric utilities, multi-utilities, independent power producers & energy traders, and gas utilities. From a diversification perspective XLU’s portfolio is less than ideal, seeing as it holds less than 40 companies total and allocates over half of its assets to the top ten holdings alone.

This ETF is by far one of the cheapest options available in the utilities space and its vast liquidity makes it a useful tool for active traders seeking shorter-term tactical allocation to this particular asset class. Investors seeking more broad-based exposure should consider JXI, which tracks the performance of the utilities sector of the global equity market.

KXI [Fact Sheet]

During economic hardships most sectors see a decline in demand for their products. However, consumer staples are often times an exception, proving to be a viable safe haven when growth is sparse if not negative across other industries. Consumer staples include everyday products like soap, laundry detergent,  basic food items, and other household products that have a low price elasticity of demand, meaning consumers will exhibit fairly stable demand for these products no matter the change in price. In fact, during times of economic slow down some consumer staples like alcohol and tobacco products are known to see an increase in demand.

KXI gives investors broad-based exposure to consumer staple companies spread out across the globe. This ETF has a just over 100 holdings and the majority of the firms are based in the United States and Europe, while exposure to corporation in the Asia-Pacific region and Latin America is also included. Notable companies included in the top ten holdings are Nestle, Procter & Gamble, Coca-Cola, Philip Morris International, and Wal-Mart.

Similar to XLU, we view KXI as a way to concentrate equity exposure in a segment that should be expected to exhibit low volatility while still maintaining some upside potential. This position allows this ETFdb Portfolio to achieve low volatility and strong capital preservation abilities despite a significant weight to equities.

Investors with a bigger risk appetite should certainly consider ECON, an appealing product with great profit potential that offers exposure to consumer goods and services companies based in emerging markets.

IDV [Fact Sheet]

With interest rates at record lows and expectations of a sluggish global economic recovery, the appeal of dividend paying stocks is bound to increase amongst investors seeking an alternative source of current income. Investing in dividend paying securities is considered a value investment strategy, since investors are focused on large companies that generate excess cash flows, which implies stability over the long-haul and the dividend payments provide a “safety cushion”.

While some investors pursue value strategies regardless of the economic environment, others view dividend paying equities as the first level of safe haven investing. When mild signs of economic turmoil emerge, investors will tend to gravitate towards stocks that provide a meaningful current return instead of those that may offer greater capital appreciation.

IDV is a great fit for this portfolio as the fund is linked to a benchmark that consists of companies that have provided relatively high dividend yields on a consistent basis over time. The nature of this product and its holdings are consistent with our safe haven theme and its international exposure is an added layer of diversification that will may further improve risk-adjusted returns. IDV gives its largest individual country weightings to Australia and the United Kingdom, and invests exclusively in developed markets outside of U.S. borders. Investors who wish to avoid international exposure should consider VIG, which measure the performance of U.S. common stocks that have a history of increasing dividends for at least ten consecutive years.

Commodities Overview

We generally believe that due to their low long-term rates of return and occasional short term volatility, commodity ETFs do not deserve a significant allocation in long-term buy-and-hold portfolios. However, certain commodities have potential to function nicely as safe haven destinations thanks to low (or perhaps even negative) correlations with global equity markets. Investors tend to flock to precious metals, especially gold, when prospects for equity markets deteriorate, making exposure to this asset-class absolutely critical for this portfolio.

DBP [Fact Sheet]

When it comes to safe haven investments, gold is one of the oldest and most popular choices amongst all types of investors. The yellow metal stands out as a tried and true safe haven that generally performs well in times of equity market turbulence as well as serving as a formidable hedge to flat currencies, which are susceptible to inflationary pressures. Also, because gold bullion makes up a substantial portion of global foreign reserves, there is some downside protection, which further contributes to this metal’s reputation as a “safe bet”.

DBP makes for a solid fit in the portfolio as this ETF gives investors futures-based exposure to the price of gold and silver. This fund can be best described as a gold ETF with a slice of silver, seeing it allocates just over three-fourths of total assets to the yellow metal, with the rest going to silver futures contracts. While silver prices do tend to be more volatile than those of its yellow counterpart, this precious metal also has the ability to take on safe haven appeal during chaotic times in the market. Additionally, silver demand is largely industrial, which provides for a source of uncorrelated returns that may reduce overall portfolio volatility and enhance bottom-line returns.

It is important to note that DBP utilizes a futures-based strategy to achieve exposure to these precious metals, which has a few ramifications on the risk/return profile achieved. First, DBP won’t move in perfect unison with the spot prices of the relevant commodities; the slope of the futures curve will also have an impact on returns. Second, the taxation of DBP may be somewhat unique, as this fund will incur gains or losses annually regardless of whether or not a position is liquidated.

One potentially interesting alternative is GLTR; that product is physically-backed, meaning that the nuances associated with futures-based strategies are eliminated. GLTR also includes platinum and palladium in the underlying portfolio of precious metals.

Fixed Income Overview

Allocations to the fixed income corner of the market is a critical component of any safe haven strategy; demand for bonds generally climbs during uncertain times since this asset class is known for its consistent performance over the long-run. In accordance with this portfolio’s defensive theme, we feel that exposure to the domestic fixed income market  is absolutely necessary, especially given our sizable allocation to equities.

AGG [Fact Sheet]

This Simple (But Effective) Safe Haven ETFdb Portfolio achieves all of its fixed income exposure through AGG, which seeks to measures the performance of the total U.S. investment grade bond market. AGG is cheap, maintains a very deep portfolio, and is incredibly liquid–three elements that are important given the objectives of this ETFdb Portfolio.

AGG allocates roughly one-third of its assets to mortgage backed securities and another third to U.S. Treasuries, with the remainder going to U.S. Corporate and Agency bonds. The majority of the holdings fall within the 3%-6% coupon range. From a time to maturity perspective, AGG is very well diversified, offering exposure across multiple time frames and giving investors access to primarily AAA credit quality holdings.

It should be noted that AGG generally isn’t appropriate as a “one stop shop” for fixed income exposure; this ETF taps into only a limited section of the global bond market. But the fixed income securities represented in this fund are the ones that generally perform well in volatile environments. Specifically, AGG is dominated by Treasuries and debt issued by agencies of the U.S. government, along with a moderate allocation to high quality corporate bonds.

ETF Correlation Matrix

Diversification is a key component of any client portfolio. The chart above shows the correlation between each component of the Simple (But Effective) Safe Haven ETFdb Portfolio over the last two years.

As is expected, there is fairly strong correlation between all of the equity holdings in the portfolio. However, fixed income exposure is a great diversifying agent, helping to smooth out overall portfolio volatility. Also notice that DBP bears very weak correlation to both the equity components and AGG, showcasing that precious metal exposure is a valuable portfolio component, especially for defensive investors.

Disclaimer

The information herein is not represented or warranted to be accurate, correct, complete, or timely. Past performance is no guarantee of future results. All investors should read applicable prospectuses before investing.

From time to time, the authors of this report or other employees of ETF Database may have a long or short position in securities referred to herein. The factual statements herein have been taken from sources we believe to be reliable, but such statements are made without any representation as to the accuracy or completeness or otherwise. [/hide]